U.K. Inflation Expectations Risk Getting Dislodged, BOE Says

Inflation has exceeded the BOE’s 2 goal target every month since December 2009, and Chancellor of the Exchequer George Osborne revamped its mandate in March to give it more flexibility to set policy. Photographer: Simon Dawson/Bloomberg

June 13 (Bloomberg) -- U.K. inflation expectations risk
becoming dislodged because consumer-price growth has been
elevated for such a long time, Bank of England economists said.

“The prolonged period of above-target inflation could
cause inflation expectations to become less well anchored,” the
researchers wrote in an article in the central bank’s Quarterly
Bulletin, published in London today. “That could trigger
changes in the nominal exchange rate, and affect consumption and
investment decisions, as well as wages and prices, and could
cause inflation to persist above the target for longer.”

Inflation has exceeded the BOE’s 2 percent target every
month since December 2009, and Chancellor of the Exchequer
George Osborne revamped its mandate in March to give it more
flexibility to set policy. While “most indicators are
consistent” with expectations remaining anchored to the target,
risks have developed, the report said. A quarterly BOE survey
published last week showed no change in expectations in the
coming year from the first quarter.

Higher energy costs, import prices, value-added tax and
regulated prices have largely pushed up consumer prices,
prompting the Monetary Policy Committee to judge it
“appropriate to look through the period of above target
inflation,” Becky Maule and Alice Pugh of the bank’s Monetary
Assessment and Strategy Division wrote in the article. The lack
of movement in most measures of inflation expectations suggest
wage growth and inflation haven’t yet been affected.

Still, “there is tentative evidence that financial market
measures of inflation expectations have become a little more
responsive to developments in the economy,” the officials said.

Policy Decisions

The MPC will continue to “monitor and assess” this data,
which remain “an important factor” in policy decisions,
according to the article.

Higher levels of uncertainty since the financial crisis
started may also continue to curb consumer spending and
investment, and may be a factor restraining the economic
recovery, according to a separate chapter in the bulletin.

“Uncertainty has remained relatively elevated over the
past five years,” said Abigail Haddow and Chris Hare of the
bank’s Conjunctural Assessment and Projections Division, John
Hooley of the Bank’s International Finance Division and Tamarah
Shakir of the Bank’s Macroprudential Strategy Division.
“Considering different strands of theory and evidence on how
households and companies respond to uncertainty suggest that, as
long as it remains elevated, some restraining effect on the
level of consumer spending and investment may continue.”

Dissatisfaction

Michael Goldby of the Bank’s Monetary Assessment and
Strategy Division noted in another article that “satisfaction
with the way in which the bank has set interest rates to control
inflation remains much lower than before the financial crisis.”
He said “net satisfaction, while remaining positive over the
past year, fell to a series low in 2012 in the third quarter,
before recovering a little in subsequent surveys.”

A separate article suggested that while cross-border
capital flows provide considerable benefits by diversifying
lending sources, BOE analysis has shown they “exacerbated the
bust once the crisis hit.” The writers said that policy makers
must monitor these flows from a domestic and international
level, and officials may need to consider new policy mechanisms
to achieve this, such as former international foreign currency
liquidity arrangements.

A chapter on the Funding for Lending Scheme, which the
central bank and the Treasury extended in April by a year to get
credit to smaller companies, noted that feedback from market
participants on the plan’s extension had been positive.

“The bank expects that a significant number of eligible
banks and building societies will sign up to the extension,”
according to the article.